Giving Just Got Better: Using Qualified Charitable Distributions to Reduce Taxable Income

The Qualified Charitable Distribution, or QCD, has been around since 2006. Recent tax law changes make the QCD more than just a convenience; it is now a viable instrument for some people to reduce their taxable income.

Using a Qualified Charitable Distribution is a method to make a charitable gift from an Individual Retirement Account (IRA). Your IRA custodian sends the donation directly to the charity or charities of your choice, without the money passing through your hands. There is no limit to the number of different qualified charities to which you can make donations using this method. A qualified public charity is one defined and approved by the IRS. You may not use a QCD to transfer IRA dollars to a donor-advised fund or a private foundation. And you may not receive any benefits from the charity in return for making the donation.

Americans, by and large, are a charitable group, giving more than $410 billion in 2017, over five percent more than the year before. Of that amount, 70 percent, or over $286 billion, came from individuals. Approximately 91 percent of high net worth households give to charity, giving an average of $25,509 in 2015. Religious groups are the largest beneficiaries of this largesse, receiving about 31 percent of the total. Education is next at 14 percent, followed by human services (12 percent), grantmaking foundations (11 percent), and health (9 percent).

In the year that one turns 70 ½ you must begin to withdraw funds from your Individual Retirement Account, including simplified employee pension (SEP) and Simple IRA’s. The IRS requires that you take out at least a certain amount, known as a Required Minimum Distribution (RMD). Dividing the IRA account balance at the end of the prior year by the applicable distribution period or life expectancy will calculate the RMD for the year. For example, if you are 70 years old you divide your account balance by 27.4. If you have an IRA with $250,000, the required minimum distribution for the year is $9,124. At 80 years of age the account balance would be divided by 18.7, resulting in a minimum required distribution of $13,369. These distributions are then subject to taxation as earned income. Roth IRA’s do not have required minimum distributions. If you have inherited a Roth IRA, consult with your tax advisor.

If the above paragraph applies to you, and you will be making donations to a qualified charity or charities anyway, a Qualified Charitable Distribution can help to make the donations, satisfy your RMD for the year, and reduce your taxable income, all at the same time.

People generally give to charity to do good and make a positive difference. Still, it is nice to get a tax break in addition to the satisfaction of doing a good deed. The increase in the standard deduction for this tax year (among other changes) will eliminate the need for many people to itemize deductions to minimize their tax bill. It is estimated that only 11 percent will itemize on their 2018 returns, down from 26 percent in 2017. If you are under 70 ½ and don’t itemize, you won’t get a tax break for your charitable contributions. If you are 70 ½ or over and utilize a qualified charitable distribution for part or all your required minimum distribution, you will still get a tax benefit even if you don’t itemize.

When you take a required minimum distribution, the IRS considers the full amount as taxable income. If you give to charity from your RMD using a qualified charitable distribution, the amount you donate will not contribute to your adjusted gross income. Beyond the obvious reduction in the amount of federal income tax you will pay, this is important for several other reasons. Your adjusted gross income can affect the amount of Medicare premiums that you pay, the ability to deduct certain items on your tax return, and the taxation of your Social Security benefits.

You may donate up to $100,000 to any combination of qualified charities. This is a per year, per person total, not a per IRA amount. It is not necessary to use all your required minimum distribution on a QCD. The amount you keep will be taxable income, and the amount you donate will not. You can even make qualified charitable distributions more than your required minimum distribution, up to the $100,000 limit. You cannot use a qualified charitable deduction with distributions from a 401(k) or 403(b) plan, or from an active SEP or Simple IRA (it is permissible from inactive accounts). While you can make a qualified charitable deduction from a Roth IRA, the income from the Roth IRA is not taxable so there is no tax benefit in giving to a charity in this way.

The tax benefit you would realize from a qualified charitable distribution from a required minimum distribution is equal to your tax bracket. For example, if you donate $10,000 from your RMD using a qualified charitable distribution and you are in the 24% tax bracket, you would save $2,400 versus taking the $10,000 as income.

Unfortunately, if you have already withdrawn money from your IRA this year, those funds are taxable. You may not take a qualified charitable distribution on money you have already received. The Internal Revenue Service considers the first dollars that come from you IRA as counting toward your required minimum distribution. So, if you believe that you might benefit from a QCD this year, it is wise to consult with your tax advisor or financial planner early on rather than later. This is not something you can pull off at the last minute.

And finally, in case you were wondering, the answer is “No” – you cannot take a QCD and take an itemized tax deduction for a charitable gift. There is no double tax break.

This blog is intended as an overview of qualified charitable distributions and should not be relied upon for any purpose other than consulting your accountant or tax advisor.